the economic problem. 1 2 resources and wants our wants for goods and services exceed the productive...

The Economic Problem

The Economic Problem

1

2

Resources and Wants

Our wants for goods and services exceed the productive capacity of the resources used to produce these goods and services.

1

3

Limited Resources

The resources that are used to produce goods and services are:

• Labor

• Land

• Capital

• Entrepreneurship

1

4

Limited Resources

Labor

The time and effort that we devote to producing goods and services.

Land

The gifts of nature that we use to produce goods and services.

1

5

Limited Resources

Capital

The goods we use to produce other goods and services.

• Includes physical capital

• interstate highways, buildings, and dams

• and human capital

• the knowledge and skill that people obtain from education and on-the-job training

1

6

Limited Resources

Entrepreneurship

The resource that organizes labor, land, and capital.

1

7

Unlimited Wants

Our wants are insatiable.

Humans, by nature, would like to have more of those things they find desirable.

1

8

Resources and Wants

We have limited resources.

We have unlimited wants.

This leads to scarcity.

Scarcity exists when there are insufficient resources to satisfy people’s wants.

1

9

Economics

Economics is the study of the choices people make to cope with scarcity.

1

10Resources, Production Possibilities,

and Opportunity Cost

The production possibilities frontier is used to illustrate the maximum quantity of two goods that can be produced due to scarcity.

1

11

Tapes Soda(millions (millions of bottles

Possibility per month) per month)

Production Possibilities Frontier

a 0 and 15

b 1 and 14

c 2 and 12

d 3 and 9

e 4 and 5

f 5 and 0

1

12

Attainable

Production Possibility FrontierS

oda

(mill

ions

of

bottl

es p

e r m

onth

)

Unattainable

Tapes (millions per month)0 1 2 3 4 5

5

10

15

z

ab

d

c

f

e

1

13

Opportunity Costs

Production Efficiency

Production efficiency is achieved if we cannot produce more of one good without producing less of some other good.

Tradeoff

Tradeoffs exist when we must give up something to get something else.

1

14

Opportunity Costs

Opportunity Cost

All tradeoffs involve a cost — an opportunity cost.

1

15

Opportunity Costs

• The opportunity cost of an action is the highest valued alternative foregone.

• Opportunity costs increase as we desire to produce more tapes.

• This explains the shape of the PPF — it is bowed outward.

1

16

Opportunity Costs

Opportunity Cost Is a Ratio

The decrease in the quantity produced of one good divided by the increase in the quantity of another good.

Increasing Opportunity Cost

Opportunity costs tend to increase because not all resources are equally productive in all activities.

1

17

Using Resources Efficiently

Marginal cost

The opportunity cost of producing one more unit of a good or service.

The marginal cost of an additional tape is the quantity of soda that must be given up to get one more tape — the opportunity cost.

1

18

Opportunity Cost and Marginal Cost

Tapes (millions per month)0 1 2 3 4 5

10

15a

b

c

d

e

f

0 1 2 3 4 5

5

Sod

a (m

illio

ns o

f bo

ttles

per

mon

th)

Increasing opportunity cost of tapes...

1

19Opportunity Cost and Marginal Cost

Tapes (millions per month)0 1 2 3 4 5

Sod

a (m

illio

ns o

f bo

ttles

per

mon

th)

1

2

3

4

5…means increasingmarginal cost of tapes.

MC

1

20

Marginal Benefit

Marginal benefit

The benefit that a person receives from consuming one more unit of a good or service.

It is measured as the maximum amount that a person is willing to pay for one more unit.

Decreasing Marginal Benefit

The more we have of any one good or service, the smaller is our marginal benefit.

1

21

Marginal Benefit

a 0.5 5

b 1.5 4

c 2.5 3

d 3.5 2

e 4.5 1

Tapes Willingness to Pay Possibility (millions per month) (bottles per tape)

1

22

Marginal Benefit

Tapes (millions per month)0 1 2 3 4 5

Sod

a (m

illio

ns o

f bo

ttles

per

mon

th)

1

2

3

4

5

MB

Decreasingmarginalbenefit from tapes.

1

23

Efficient Use of Resources

Efficiency

• Implies that we cannot produce any more of any good without giving up something that we value even more highly.

• We compare the marginal cost to the marginal benefit.

1

24

Efficient Use of Resources

• If the marginal benefit of the last unit of a good exceeds its marginal cost, we increase production of that good.

• If the marginal cost of the last unit of a good exceeds its marginal benefit, we decrease production of that good.

1

25

MC

Efficient Use of ResourcesM

argi

nal c

ost a

nd w

illin

gnes

s to

pay

(

bottl

es o

f so

da p

er ta

pe)

Tapes (millions per month)0 1.5 2.5 3.5 5

1

2

3

4

5

MB

Bottles of sodathat people are willing to forgo

Bottles of sodathat peoplemust forgo

Cost exceedsbenefit

Benefitexceedscost

1

26

Economic Growth

Economic growth is illustrated by an economy’s expansion in production over time.

1

27

Economic Growth

The Cost of Economic Growth

• The development of new goods and better ways of producing goods and services is technological change.

• The growth of capital resources is capital accumulation.

Does economic growth allow us to avoid opportunity costs?

1

28

PPF1

Economic GrowthT

ape-

mak

ing

mac

hine

s (p

er m

onth

) c

1 2 3 4 5 6 7 Tapes (millions per month)

2

4

6

10

8

b

a

PPF0

If weproduce 6 machinesa month (b), thenthe PPF rotates. We will be able to produce more tapes in the future.

b'

a'

1

29 Economic Growth in the United States and Hong Kong

Since 1960, Hong Kong has grown more rapidly than the United States.

Hong Kong has devoted a bigger fraction of its resources to accumulating capital.

1

30 Economic Growth in theUnited States and Hong Kong

Consumption goods (per person)

Cap

ital g

oods

(pe

r pe

rson

)

a a

b

Hong Kongin 1960

United Statesand Hong Kongin 1998United States

in 1960

c

0

1

31

Learning Objectives (cont.)

• Explain how economic growth expands production possibilities

• Explain how specialization and trade expand production possibilities

1

32

Gains from Trade

Comparative Advantage

A person or nation has a comparative advantage in an activity if one/it can perform an activity at a lower opportunity cost than others.

Why is there a difference?• Differences in abilities

• Differences in resource characteristics

1

33

Comparative Advantage

Tom’s Factory

• Can produce 4,000 lengths of tape/hour or

• Can produce 1,333 cases/hour

Opportunity Cost

• To produce 1 case, he must decrease tape production by 3 lengths — opportunity cost.

• To produce 1 length of tape, he must decrease case production by 0.333 case — opportunity cost.

1

34

Comparative Advantage

Nancy’s Factory

• Can produce 1,333 lengths of tape/hour or

• Can produce 4,000 cases/hour

Opportunity Cost

• To produce 1 case, she must decrease tape production by 0.333 lengths — opportunity cost.

• To produce 1 length of tape, she must decrease case production by 3 cases — opportunity cost.

1

35

Comparative Advantage

1 2 3 4

1

2

3

5

4

Cas

es (

thou

sand

s pe

r ho

ur)

Nancy’sPPF

1Tom’sPPF

4

b

b'

a

Nancy’s opportunity cost:1 tape costs 3 cases, and 1 case costs 1/3 tape

Tom’s opportunity cost:1 tape costs 1/3 case, and 1 case costs 3 tapes

Trade line

c

Tape (thousands of lengths per hour)

1

36

Absolute Advantage

• An absolute advantage exists when a person or nation can produce more of a good than another.

• Individuals and nations can have absolute advantages in any or all goods.

• However, it is not possible to have a comparative advantage in everything.

1

37 Dynamic Comparative Advantage

• People or nations can become more productive simply by repetition --learning-by-doing.

• Dynamic Comparative Advantage results from learning-by-doing.

• Examples: Hong Kong, South Korea, Taiwan

1

38

The Market Economy

Two key social institutions organize trade among nations.

Property rights:

• Real

• Financial

• Intellectual

1

39

The Market Economy

Two key social institutions organize trade among nations.

Markets

A market is any arrangement that enables buyers and sellers to get information and to do business with each other.

1

40 Circular Flows in the Market Economy

1

41

The Market Economy

Coordinating Decisions

Markets coordinate individual decisions through price adjustments.

1

42

NEXT

A First Look at Macroeconomics